Exam 23: Swap Contracts, Convertible Securities, and Other Embedded Derivatives

Exhibit 23.5 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Exclusive Industries has debentures outstanding (par value $1,000.00) convertible into exclusive's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years. -Refer to Exhibit 23.5. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 13% per year compounded semiannually.

In an interest rate swap, the fixed rate payer profits if interest rates fall.

____ are debt instruments that have their principal or coupon payments tied to some other underlying variable.

Exhibit 23.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.3. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Megabuks.

Forward rate agreements usually require substantial collateral.

Exhibit 23.9 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The Skalmory Corporation has entered into a 3-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5% per year and receive 6-month LIBOR. The notional principal is $10,000,000. -Refer to Exhibit 23.9. What is the market value of the swap to the Skalmory Corporation?

Exhibit 23.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and McIntire.

Exhibit 23.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years. -Refer to Exhibit 23.6. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 14 percent per year compounded semiannually.

Exhibit 23.2 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 * 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 23.2. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden.

Exhibit 23.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 23.7. Assuming that one year after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has fallen to 7% per year, calculate the market value of the 8% fixed rate bond based on $100 face value. Settlement is on a semiannual basis.

Exhibit 23.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: -Refer to Exhibit 23.4. Barring default by PU or BGI, how much compensation does the swap dealer receive each month?

Consider a pension fund manager that wishes to convert $10 million from notes paying LIBOR to stocks, using an equity swap. The equity swap should be structured so that

An interest rate collar is a combination of a long position in either a cap or floor with a short position in the other.

An example of a commodity-linked fixed income security is a

The minimum price of a convertible bond is

The writer of a ____ agreement makes settlement payments when LIBOR is less than the striking rate of the agreement.

All of the following are normal characteristics of a convertible bond, except

Exhibit 23.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 23.7. Assume that one year after the swap was initiated the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year, calculate the market value of the 8% fixed rate bond based on $100 face value. Settlement is on a semiannual basis.

An investor considering investment in warrants as part of an overall program, should consider which of the following?

A floor agreement is a series of cash settlement interest rate options, typically based on LIBOR.